The Tax Cuts and Jobs Act of 2017, "The Tax Bill", has many provisions that will affect the business aviation community.
100% Bonus Depreciation of New and Used Aircraft
One of the biggest tax savings in The Tax Bill is the increase for bonus depreciation from 50% to 100%. The Tax Bill also expanded the definition of Qualified Assets to included used equipment as long as it is the first use by the taxpayer. Historically, bonus depreciation had only been available for purchases of new equipment.
Bonus depreciation will remain at 100% for purchases between September 27, 2017 and December 31, 2022. After 2022 the bonus depreciation will be reduced to 80% for property placed in service in 2023; 60% for 2024; 40% for 2025; and 20% for 2026. The first year bonus depreciation will then sunset after 2026.
Tax planning is going to be very important so that taxpayers understand if they qualify to take bonus and how to maximize this first year bonus depreciation deduction to ensure that your non-business guests and spouses on the aircraft don't result in an unexpected disallowance of some of this first year depreciation. Planning strategies might include an increase in outside charters on another aircraft for any personal passengers and personal flights in order to decrease the percentage of aircraft expenses disallowed under IRC 274.
It is also important to understand the depreciation recapture provisions are still applicable. A reduction in business use in the future could trigger a taxable recapture of the excess depreciation taken over straight line. Therefore, aircraft owners need to be in communication with their tax consultants to ensure they understand the recapture provision.
No More Like-Kind Exchanges
One of the less favorable changes in The Tax Bill is that the deferred gain from like-kind exchanges of aircraft will not be available after 2017. The 1031 exchange rules will only be applicable to real estate that is not held for sale going forward. The negative tax effects of this change will be offset by the allowance of 100% bonus depreciation. However, the offsetting tax impact for the lack of ability to engage in a like kind exchange is temporary because the bonus depreciation is phased out as shown above and sunsets after 2026.
Federal Excise Tax
The Tax Bill has several other items that directly or indirectly will affect the business aviation community. They have added language to subsection 4261 of the Internal Revenue Code to clarify that the Federal Excise Tax (FET) of 7.5% does not apply to owner flights on managed aircraft. This won't provide much in savings for the aviation community since most, if not all, of us were already taking this stance, but it is nice that we shouldn't have to worry about this coming up in an excise tax audit in the future.
Unreimbursed Employee Business Expenses No Longer Deductible on Schedule A
The Tax Bill increases the standard deduction and makes significant changes to what can be deducted on Schedule A as an Itemized Deduction. There are several changes to Schedule A Itemized Deductions that will affect business aviation. One of larger impacts will be that unreimbursed employee business expenses will no longer be deductible as an itemized deduction through Form 2106. This will have little impact on partnerships and LLC's that are electing partnership treatment because unreimbursed partnership expenses for business related charter and other aircraft costs can still be added as a deduction to Schedule E (or the applicable form) above the line. However, corporate shareholders, including s-corps, will lose the ability as an employee to deduct any unreimbursed business expenses for the charter trips taken and aircraft costs incurred.
If you or your client is adversely affected by this change in law, you may be able to work with your tax advisor and the corporation to adjust their compensation package and add an allowance for reimbursement from the corporation for these expenses. This would allow the company to reimburse the employee for these expenses and deduct them at the corporate level. The reimbursement will not be a taxable fringe benefit as long as it is reimbursement through a written accountable plan. Reimbursements from a non-accountable plan are taxable fringe benefits and need to be included on the shareholder's W-2 as wages, which would reverse the tax benefit received by the company. It is important to evaluate your current deductions to see if any additional tax planning is necessary to ensure that you don't lose those deductions going forward.
Disallowance of Commuting & Business Entertainment Expenses
As with all new laws there are things that will need further explanation before we can understand the true impact to our operations. Two things that I am following are the interpretations to the changes made to disallow deductions for employee commuting and business entertainment expenses. These changes will likely impact how we have historically calculated the percentage of aircraft costs that are disallowed as an income tax deduction in accordance with Section 274 of the Internal Revenue Code ("IRC").
Business Entertainment Expenses
Prior to the passing of The Tax Bill, business entertainment expenses for entertaining clients and marketing efforts to achieve a business objective have been deductible. The Tax Bill disallows ALL business entertainment expenses.
Another change in The Tax Bill is that commuting between residence(s) and the place of employment is not going to be allowed as a deduction without a safety related purpose, which I infer would need an Independent Security Study, or equivalent study with 24/7 security as we have seen in Treasury Regulation 1.132-5.
The change to disallow commuting expenses may impact how we have historically calculated the disallowed expenses for aircraft operations. In the past, commuting was a grey area and if a company could substantiate that the commuting flights were personal non-entertainment then imputed income on the fringe benefit was calculated for the employee, but the non-entertainment commuting flights would not affect the calculated percentage of disallowed aircraft expenses under IRC 274. This allowed a higher percentage of all aircraft costs to be deducted on the company's tax return.
Does the change in the law to disallow commuting expenses affect our ability to consider these flights personal non-entertainment for the purposes of determining the disallowed percentage of aircraft expenses under IRC 274? Will we need to include the commuting flights in the entertainment bucket going forward...? I'll update the blog as new information is available, but be on the lookout for more guidance on this topic and other items that arise as we get a better understanding of The Tax Bill.